no published rulings. We have only private rulings which under 6110(j)(3), we can't cite or rely on as precedent despite the fact the Internal Revenue Service agents are in fact citing them, relying on them and using them in their work as guidance.

Turning to the local problems that we have observed in the Kansas district, the Kansas agents to a man—I should say we have had five auditors, five different agents and at least those five to a man, believe the use value is unfair and gives the farmer an unfair advantage. They will freely admit this when asked if they are trying to disallow the use value election.

The first difficulty in Kansas deals with finding comparability of leased land. The regulations have perverted "comparable" to mean "identical." We have had problems with proving comparability when roads are hard surfaced as opposed to gravel. We have had difficulty with improvements depending on whether they had wood shingled roofs or tin roofs. On a 2,000 or 3,000 acre farm or ranch in western Kansas, the improvements are irrelevant to the valuation.

The second thing that we have had difficulty with is the agents will put nothing in writing. Everything has been oral at this point and we have had no written discussions with them.

No. 3, as my predecessor just mentioned, they have tried to push us out of (e)(7) and into (e)(8) with the result that we end up at fair market value, using a capitalization rate of 2 to 4 percent which the Kansas district uses.

No. 4, the expense of compliance far outweighs any advantage to the Service. We have come up with affadavits, certified copies and we have spent a great deal of time running around the country looking for cash leases which is sort of a silly endeavor, I think, for grown men to do.

No. 5, I have already pointed out the agents' attitudes.

In conclusion, it is our position that the use value provisions have not been observed on a national office level or the local office level as they have been enacted.

I think it is a very dangerous precedent we are setting allowing local agents, at least in the Kansas district, to run around the State and for that matter the country, establishing national tax policy.

Speaking as a trial tax lawyer, there is no question in my mind that we can litigate our way out of this mess. I think there ought to be a much more productive, simpler, and less expensive way of doing that and I think we need some help.

Thank you.

Senator GRASSLEY. Thank you, Mr. Ridenour. I would like to go now to Mr. Hutton.

STATEMENT OF DAVID J. HUTTON, HUTTON, KENNEDY & NEATON, MINNEAPOLIS, MINN.

Mr. HUTTON. Thank you, Mr. Chairman. I appreciate the opportunity to testify before this committee.

The IRS has recently issued three interpretative rulings, which I feel ignore the statutory language of section 2032(A) and the congressional intent of special use valuation.

In these rulings the national office has indicated and the revenue agents have followed, a policy whereby a portion of the real estate indebtedness is not allowed as a deduction when an estate makes the special use valuation election.

Let me illustrate, by example, the estate tax effect of the position taken by the Internal Revenue Service. If a decedent owned a 400 acre farm that was qualified for special use value which had a fair value of $2,000 an acre or $800,000 and a special use value of $800 an acre or $320,000, by the election of special use valuation the gross estate is reduced by $480,000.

In this example, the decedent also had a mortgage against the farm of $300,000. It is the position of the Internal Revenue Service, by its three revenue rulings, that because the gross estate farm was valued at 40 percent of its fair market value because of the special use election then only 40 percent of the mortgage indebtedness is allowed as a deduction. Therefore, instead of obtaining a $300,000 deduction for the mortgage indebtedness the deduction is limited to $120,000.

In summary, instead of having a $480,000 benefit by special use valuation, the estate was only reduced by $300,000.

Senator GRASSLEY. Let me interrupt you here. I think this is the first time that has been pointed out today.

Mr. HUTTON. That is correct.

Senator GRASSLEY. OK. I appreciate it. Go ahead.

Mr. HUTTON. There are two statutes and I refer to them in middle of the second page of my outline that are involved.

One of them is the special use statute which we have been discussing. The other one is section 2053; 2053 allows for the deduction in calculating estate tax for expense of administration, indebtedness that the decedent owed at the time of his death and they meet any taxes.

Under subpart 4-section 2053(a)(4)—provides for the deduction in calculating the estate tax for unpaid mortgages on or any indebtedness in respect of property where the value of the decedent's interest therein is included in the value of the gross estate.

Under section 2032(A), it starts out by providing that if you are a citizen of the United States and you make the election, then it says "for purposes of this chapter", the "value" of qualified real property shall be its "value" for the use under which it qualifies as qualified real property.

It seems very clear, in my reading of section 2032(A), that for purposes of chapter 11 which covers the entire estate tax laws, that value of qualified real property shall be at special use value if the election is made under section 2032(A).

I feel the Internal Revenue Service has no basis for reading into the term value under section 2053(a)(4), the term "fair market value" and that is in effect what they have done.

I have an estate where the Internal Revenue Service is presently proposing the disallowance of approximately $175,000 of a $330,000 mortgage indebtedness against the qualified property. This is resulting in a $36,000 tax deficiency which may require my clients to sell a portion of their farm to pay this additional tax liability.

If they sell a portion of the farm to pay this tax liability, this will result in an early disposition of the qualified and trigger a recapture and paying the higher estate tax.

It seems that the farming unit that carries a substantial amount of debt, has the greatest need for estate tax relief and is actually being penalized by the position taken by the Internal Revenue Service.

Back in my beginning example, an estate where the real estate had no indebtedness against it, the special use election would reduce the gross estate by $480,000. Because the estate had indebtedness against the real estate, the taxable estate was reduced by only $300,000.

Thank you for the time for appearing before your committee. Senator GRASSLEY. Thank you. I have a couple of questions and/ or comments of a couple of you.

First of all, I would like to thank all of you for your expertise as practitioners and telling us how you have been affected by it.

It is very important to us that we have people out there in the trenches working with these laws to testify to tell us whether there are shortcomings both in basic law as well as the administrational law.

I think most of the fault so far, as pointed out, has been with the interpretation and regulations in pursuit of the law than it has the basic law itself.

I think I would like to make a point that I know about Bob Furleigh's case that maybe was or was not included in his testimony, but it is my understanding that you made some basic plans for estate purposes based on Neil Harl's book and his interpretation of how the 1976 law should be interpreted.

He was very involved in that 1976 legislation and since that time has worked with individual Congressmen.

Then in August after your father's death, you found out that what you had planned was no longer the case.

Mr. Furleigh. That is right, Senator.

Senator GRASSLEY. Then, I would like to use you as an example of a classic family farming operation.

Your farm was bought by your father in 1948, 265 acres. I assume that that was before you were out of school so you helped contribute to the operation of that farm while you were still in school, probably in those days for little or no pay.

Then you have farmed the farm for quite a few years recently, at least, well beyond 8 years, as a matter of convenience to your father because he was in a nursing home. You cash rented that farm.

Knowing your background and your love for farming, I anticipate that you are going to be farming for at least 15 years after your father's death.

The whole purpose of special valuation, the whole purpose of the estate tax reform of 1976 and what we are anticipating in future estate tax reform is to keep a family farming operation like from your father to you and then maybe you will have sons who will want to farm, an institution of American society.

If you were to be hit with this higher estate tax and have to sell off part of your farm to pay the taxes, or even if you have to

borrow heavily against it, then that might make your family farming operation less efficient than it previously was.

I ask you that partly as a question, but also go to great lengths to demonstrate how the cash rent that you paid your father in recent years of his life, may have precluded you from qualifying for special use. It seems to me your father's and your farming operation and your rental arrangements and the continuation of you farming that farm is a perfect example of what we want to accomplish through estate tax reform.

Does all of that apply to you?

Mr. FURLEIGH. Well, I think so. That is probably why I am here. Senator GRASSLEY. OK, I guess I want to go to some lengths with that because I want that to be pointed out to people who do not understand the purpose of estate tax reform.

It is to preserve the very generation to generation of property so that we have the family running the farm. That is the most efficient food producing unit anywhere in the world, compared to the corporation farms of America or other nations or compared to the state farms and collective farms of other societies.

Mr. Ridenour, there was a point in your testimony where you started to say and I didn't get the point. Could you clarify this? Mr. RIDENOUR. We have seen this problem in trying to qualify the estates we have filed for use value. The agents, and I shouldn't say all of the agents, I should say three in particular, have freely admitted that is exactly what they are trying to do-prohibit our estate from qualifying for use value. It has not been a problem having them admit that.

Senator GRASSLEY. OK.

Mr. RIDENOUR. I don't know what good that admission does, but they have willingly admitted that use value is unfair and that they are trying to push us out of use value. That is correct.

Senator GRASSLEY. OK. I wish I had time to ask some more questions, but I think I better dismiss you as a panel and hope and assume that you would all be available for any followup that my staff would need.

Is there anybody who would prefer not to be contacted in the future if your help would be needed?

Well, since there are no heads signalling no, we will assume that you will be available at any future time.

Thank you all very much.

[The prepared statements of the preceding panel follow:]

TESTIMONY OF BO3 FURLEIGH

BEFORE THE SENATE COMMITTEE ON FINANCE,

SUBCOMMITTEE ON OVERSIGHT OF THE INTERNAL REVENUE SERVICE

PUBLIC HEARING ON REGULATIONS CONCERNING IMPUTED INTEREST RATES AND ESTATE TAX LAW GOVERNING VALUATION OF FAMILY FARM AND OTHER SMALL BUSINESS PROPERTIES.

MONDAY APRIL 27, 1981

CONTENTION:

A recent administrative regulation by the I. R. S. denying use valuation because of cash rent paid within a family is likely contrary to the intent of Congress, if that intent was to fashion the use valuation to preserve the family farm or business and avoid artifically high estate taxes..

Evidence is offered that our farm is indeed a family farm and that the denial of use valuation will jeopardize the preservation of that farm intact.